Tesco Plc: An Undervalued Retailer

This article is mainly addressed to people already familiar with Tesco and ideally, but less important, with experience investing in the UK. It requires that background familiarity to better understand what I'm talking about, but just in case you are not, as a very fast introduction, I will say that Tesco is the third-world's biggest retailer and the first in the UK. If you do not know it, it might help to think of it as a UK version, similar, but with important differences, to Walmart, which I'm sure many more of you know of.

I will not get into an analysis of Tesco's financial statements or valuation ratios. Valuations based exclusively on financials, while necessary, are not enough, mainly because any educated investor can do them based on certain assumptions, but the hard work is getting those assumptions conservatively right and that can only be done by learning and understanding the drivers and dynamics of the business itself. I will try then to go a little bit beyond financials numbers and ratios into less obvious subjects in order to hopefully add some value.

I will mainly focus here on its assets, specifically its real estate properties. Tesco's capital expenditures are higher than what I would usually feel comfortable with, but this is not a usual case. I forgive it because it mainly buys its properties in order to put them to work as a retailer, or for example in China as a mall, and in the process increasing their value. This could be described as a real estate company with a retail operation, being by its combination more valuable than a pure retailer or a pure real estate company. The side effect is that its capital expenditures are therefore higher than its peers' mainly due to the fact that it invests in its expansion both in the UK and internationally in big part by buying properties at cheap prices and developing them.

The key though is that in the real world, not the accountancy world, real estate does not depreciate; it even usually appreciates above inflation in the long term, if it's bought correctly, not in the midst of a commercial real estate bubble, which was not the case. So the big capex is not a problem at all due to the fact that it owns most of its properties. Adjusting for this, i.e., if it only rented real estate, the capex would be quite small.

The stock price is therefore cheap compared to its earnings power and its underlying real estate, which is estimated to be worth more than its $25 billions of market capitalization! Book value is understated because of the real estate properties which are not reflected in the assets, showing them as much smaller than what they are and affecting the whole valuation of the company. Due to the unreal property depreciation charges required by law, the book value is stated as much lower than what it really is. For someone who wants to make money with the stock this has fortunately not yet been recognized by the stock market community and has therefore contributed to produce low market prices, quite nice for an entry point since you are buying a business with properties behind for much less than their worth.

But this fact means that if the company should be sold that value would emerge. Additionally, if one wants to absolutely limit the possible loss in a worst case scenario, it is interesting to consider the fact that the stock price downside is protected by the underlying properties behind, which act as a cousin limiting its potential downside to their real market value. The current market value of the properties is estimated to be 36 billion pounds, and the current debt is 6.7 billion pounds. Therefore Tesco has a market value cheaper than all its properties minus its debt. If that is not cheap then what is?

You can therefore at the very least value the company by that number obtaining already a big margin of safety because if the company had to be slowly liquidated and sell its properties at the estimated worth of 36 billions and pay all its 6.7 billion debt, the 29.3 billion left would still be higher than the current 25 billion of market value! I rephrase: a liquidation value bigger than a market value! Therefore the current market price is only justified by persistent negative earnings expectations, i.e., destruction of value or by substantially ignoring the properties or by not believing management of their estimated worth, or finally by a combination of any of them. But if those properties are just close to what management estimates then at the time that they will be adequately recognized by the market participants the stock will appreciate correspondingly.

A spin-off of its real estate would produce two companies which would add up to a much higher value than the current company, but relying on that is a big bet and not even necessary because eventually the real value should be recognized. A catalysts for that recognition could be for example the gradual and profitable sale of part of its properties putting in evidence their value. Tesco has already quite successfully started doing that and management has been clearly communicating it. If it was a real estate company the market would value it as such and recognize the value of it's properties, but perceived as a retailer the market seems to massively overlook them and just remembers them if they are told or better yet when their existing value is proved by their sale. This misappreciation combined with a focus on high capital expenditures could explain why it's p/e is 40% lower than its peers such as the world's biggest retailer Wal-Mart or even smaller players such as Colruyt in Belgium.

The company is expanding quite well internationally, specially in eastern Europe and even better in Asia. I have my doubts about the USA, but it still represents a very small proportion of their business so if it should write down their investments there it would not be a big deal. There could be some problems in Europe due to the recession, specially in nationalistic countries such as Hungary. If its economical problems escalate, international companies could be boycotted there, and as a consequence Tesco, an important foreign retailer there, could be affected. On the positive side it has several other potential growth drivers beyond the international expansion, such as its bank, its retailing operations, and its multi-channel products such as online sales, non food items, clothes, telecommunications, etc...

Warren Buffett, a famous north american investor, recently added, I just read about it 2 days after I initially bought (note I'm joking by introducing Warren Buffet as a famous investor, I guess it would be hard to find 1% of the readers here who do not know him but I have been writing this for hours and couldn't resist the joke plus I wanted to light up a bit what otherwise would seem a too serious and dry subject). Unfortunately for those as me that want to accumulate cheap, and are happy with a falling stock, he seems to have put a floor on the stock price. He is now more than a 5% owner, making it one of its biggest recent additions. Also there has been some inside buying by some directors, at least 3 that I know of added after the recent slump in the share price. Worse like for like Christmas sales in the UK affected the market price, it seems like this was a total surprise, and it's the first time it happened in several years, the market did not like it, I think it over reacted though, and Warren Buffett seems to think the same. He enormously increased his holdings there, he said months before that he would if the price dropped and he immediately did it when it recently crashed. Admirable consistency and sign that he views the recent drop as a temporary problem of no structural or fundamental consequences but more as a buying opportunity.

The UK business seems to need more investment than what it has had, or at least more focus, it seems that sales are slowing and that customers and employees are less happy and less well treated than a few years back, this can clearly be seen online in places such as twitter, also competition has caught up quite well. So the key is not to let the UK deteriorate, since that's the cash cow part of the business. Nonetheless, given its management, I have faith that they will manage to address the problems. There are several positive factors such as its earnings; its historically low p/e and the real estate huge margin of safety due to its market value; the stable and generous dividend; the future of the emerging expansion; the many other growth drivers already mentioned; such as bank; non-food; on-line sales; the relatively not big and falling debt. Due to that I am sure that the current cheap price offers quite a good risk reward that more than offsets the temporary head winds and offers a great entry point in a safe and big company.

Disclosure: I just added more Tesco, this time for costs considerations, to avoid the UK stock transaction tax, high UK commissions and currency costs, I did it via the USA ADR (TSCDY.PK): 70 shares @14.9 on Tuesday, February the 14th, equivalent to 210 UK shares. I am now holding the equivalent of 460 UK shares and 250 shares for my mother in law, whose money I manage. All in all at an average price of 314 UK pence. It represents a relatively small 1.3% position of my portfolio but it could become much bigger.

Cheers!

Juan

About the author:

Jose Vasquez

I was born in Spain and lived in France, Chile, USA and Belgium. I used to work in IT and Banking. I am a family man, I have a lovely wife, 3 sons and one step daughter. I have humble tastes, I like to stay home and read about companies. I started investing before the internet bubble. I knew little and liked technical analysis so my results were bad. Fortunately I did not have much to lose. Some years later in 2006, bored of doing real state investments, I opened an interactive brokers account and restarted. This time, not wanting to make mistakes, I decided to follow a model: Warren Buffett, he was at good making money via stocks. So I started reading about him, his shareholders letters, the books that he recommended, etc... I started applying his principles, reading 10K's digesting all sources of information. I started buying good and cheap companies to hold forever unless something changed fundamentally. When the housing crisis started I was 75% cash. By then I had identified good companies at very cheap prices so I invested most of my savings in stocks. It doubled fast. By the second semester of 2009 I turned my software company into an investment vehicle and dedicated myself full time to it. I changed lifestyle and moved from Belgium to the beach, Brazil, north east coast (www.kuchita.com). The goal was to keep fixed costs low in order to be able to live with a minimum 6-8% yearly return, to move away from the inhuman life of civilization and to have some peace and sunny weather. Now I can think and study about companies 60 hours/week. I can finally do what I want full time and can say that I have never been so happy, specially also with my just born 4th son, my other great kids and my sweet wife who supports me fully while I study most of the day and patiently wait for the opportunity to make a swing ! My portfolio is disclosed here: http://www.kuchita.com/view/sumo.php For more:

Personally, I am doing some scuttlebutt research on this. Most of the people I know who have lived in the UK, by and large, have been happy with the stores (though the information is dated and confined to a specific region).

Have you had any personal experiences? Any other Gurufocus readers with opinions / experiences in TESCO?

Hi Balajisridharan, I have read some other Gurufocus articles about it, but just focused on basic financial stuff, not many interesting qualitative considerations, there is though one article that mentions and goes a bit deeper in the real state assets but I don't think I read it in Gurufocus it was an old article cant remember when, Ill check my mail to see if I have it somewhere, it was a fellow investor that sent it to me. I have read lots of different online comments about employees, some not so happy some yes, the not so happy ones are the ones I focused on more to see how bad things could get. The more unhappy employees were the new employees, who have less benefits than the older ones, such as less payment on week-ends or extra hours. I have also read about some UK employees complaining that some stores are really under-staffed and about stores that are just too little attractive for the customer. Apparently that their slashing costs in the UK has been so big that it has started to affect the customer experience. Customers see Asda as better value but not as good quality and not as many products, so I would no worry too much because cheapest is not necessarily the best. Aldi is super cheap and well managed but the quality kind of sucks if you ask me, and I'm very greedy, but I'm not willing to trade bad taste and nutrition for a cheaper price! Its food products are still very good but they need to take care of their employees and make it a minimum aesthetically nice for the customer to go shopping there. I have also read that product prices rebates are complicated even that some might be considered misleading and confusing for the clients with so many different rebates and coupons and offers that the customer has a hard time finding out how much he will really pay for the product on the check out.

It is consistent with what I have been reading online as well. I think, long term, the employee and shopping experience are fixable problems. The CEO has already alluded to attacking these. This might cause short term costs but will result in a wider moat for the company.

What are your thoughts on the long term threat from a e-commerce only model like Amazon? (On non-food and some food products) Will TESCO online be able to compete with AMZN long term? I do not know how much of a threat is AMZN is in UK (as compared to the US) I keep wondering about AMZN when I think about my WMT position long term.

Hi Balajisridharan, funny that you mention Wal-Mart since it is my other retailer, I actually currently own more of it than Tesco, and it has performed Ok but it took a long time to fix its like for like sales, so my experience is that its not an easy problem to solve the like for like, but they are solvable and meanwhile I added, allways very near the bottom prices. So due to Wal-Mart I have been evaluating Amazon too but in the Uk its presence is much smaller than in the USA where its mainly focused to compete in retailing, so I really do not think it is a problem. Also the online sales are doing pretty well for Tesco itself and the margins are quite high so I am more or less happy with its future specially considering that it owns a lot of stores and the ones that are performing poorly could be used as inventory stores for online goods so I think they are in quite a good position compared to any other on line competitor. Retailing is about size, it has become a commodity and as such management, operational efficiency and most importantly size is what matters, the biggest companies can have huge economies of scale and beyond a certain point nobody can compete easily with them, Tesco being the biggest UK retailer should therefore not have a problem as long as management does not screw up, and they seem to be doing a good job. They have had a few problems but I do not consider those problems structural.

I have been following Tesco since a couple of years, always liked it but never felt completely ok due to the price basically, not that it was expensive but I found it a bit aggressive and never liked its entry in the USA, so I had my doubts. But price matters and now its much cheaper, at current price Tesco is a safe bet, I would not have bought it at a higher level mainly because I do not like companies that grow fast, specially retailers growing fast internationally. I think it can be difficult to do, only Wal-Mart has been successful doing it and Tesco too but Tesco has much less international history so I had doubts to buy at higher prices but at current prices it seems very safe. Carrefour is a sad example of how difficult international retailing can get. So as an investor in such companies you better be sure management is quite good.

I read the article you mentioned from BronteCapital and the worried Tesco investor losing money, I agree with several things he did and said, but with the level of doubts he has I do not understand how he invested so much to start with. And more than anything I would have never bought Tesco at the price he did, that's key. But if I was in his position I would buy more now, even if I was losing money, unless his positions are too big. If a company you like gets much cheaper and you still like it I would just add more. I would have never invested in Bank of America like him so I probably have several philosophical investing differences with an investor that could have made such a decision. So in resume, at current level Tesco is safe, but 40% higher it is not so safe anymore, not too unsafe either but definitly not something I might add. But since all I care most about is safety and the price seems to give it now, and not before, I added. That said, the comments are excellent, but I do not think that perceived problems are irreversible, retailers are extremely competitive and have all reached a high level of perfection. Differences are narrow, size, scale and management is what matters. You cannot please all customers, I despise Aldi's quality, yet one good friend loves it, and when I eat at his house the food is quite OK, so even I do not perceive the differences clearly always, they are small maybe, psychological even. Scale/management operational excellence is essential, Tesco just changed CEO, it deserves a chance. There is side for 2 or 3 big retailers in that industry, sometimes one can have problems, as long as they are addressed its ok. Look at Wal-Mart, the last years the stock went nowhere but they are addressing the problems, and the stock caught up, patience is key, the time to invest is when perceived or non too important problems arise and over-affect the stock, so maybe now.

Nice to read your views on Tesco....your article sums up my views as well..I also see the property assets as the main factor demonstrating the current undervaluation of the stock. I also see the UK market as a cash cow, with temporary problems that can be solved...and we mustn't forget that Tesco is the clear market leader in the UK which gives scale advantages long term. The future growth lies in Asia...and the potential there is huge....and Tesco has an established position in several important markets. The company has a long tradition of innovation and growth and I hope for a good future...so I also recently added more.....feeling secure in the knowledge that Warren Buffett had done likewise.

I also read some time back your excellent article and completely agree that the main growth driver is Asia, I am absolutely impressed about how well they have done in South Korea and Thailand. I also agree with this article where it mentions that the difference about Wal-Mart is that the latter is dominant in rural areas, whereas Tesco is dominant in urban areas but while urban areas real-state are still found cheap not even a crazy competitor would be able to afford acquiring the properties that Tesco has in urban areas, which were acquired when land was considerably cheaper in inflation adjusted terms.

Still holding CAF in Spain (hope yes) ? I am very please with how excellent it has done, specially considering the situation in the country ! I will maybe add more if I have the opportunity.

Interesting to know that your big position is Reckitt Benckiser, I'm going to look into that one, I once supercifially did it and liked a lot its business.

Cheers and good luck with your construction work, but hey, don't overlook to much your investments though :), and next time you come to Brazil let me know, you're welcome here!

Thanks KelpieCapital I read your article some days ago and like a lot how critical and easy to understand it is and how it immediately gives you a broad overview of the company. I specially loved the very comprehensive and conservative sum of parts evaluation !

Tesco's biggest threat is Tesco itself. The recent CEO change and top management exodus has not been well received by investors. Superficially I am myself also much more attracted by the previous CEO than the current one, I read that he reached the status of a legend so. A CEO like that stepping down is always difficult to replace, simply for charismatic and image reasons, but it can be seen as an opportunity to get better entry points. While the current CEO says always the correct things his face and body language does not seem to accompany it, but OK that's maybe going a little bit to far... Rational and successful actions are more important on the long term than image and the current CEO has a history of excellent career development, lots of international experience with excellent performance and comes from the lowest possible rank in the company.

PD: At least the risk of overpaying for a company, especially with global blue-chip companies, seems to have diminished.

Hi Juan, completely argree with you views and thought process. I am a UK investor involved in retail and tescos issues are minor. It still dominates the UK supermarket sector and its issues are principally that it has sent its best people to either the US or asia, but in the last few weeks has announced that its is bringing a couple of its best people back to the UK and is planning to invest in more specialist staff in the UK (butchers , greengrocers etc) to improve service levels. Its market shares is way way ahead of its competitors and it still has over 30% of the market. A couple of upsides to be realised over the next few years are also the bank which it will be launching and also an improved website for tesco direct which will basically act like amazon (tey are currently signing up a large number of ecommerce partners) which will enable customers to buy products from numerous retailers and enable you to collect from local tesco stores as an option rather than people having to wait at home for deliveries, with tesco taking a significant percentage of the profits. This will enable specialist ecommerce operators to have effectively have over 2000 pick up points in the UK instantly. This will be launched in 2012 and has huge potential with a significant advantage over amazon.

Thanks for sharing Get Gould! I wasn't aware about some of the things you mentioned, great to know it specially when it comes from an investor there. I also do agree that Banking can become big, specially mortgages due to its real state experience, and also because UK banks have a big image problem still and they could capitalize on that.

I thought about the advantage they have over amazon due to their huge amount of real state that can be used as pick up or storage point for on-line sales! I think there are definitely a lot of growth drivers.

I was pleased to learn that the recent slump in the share price was influenced by Neil Woodford, one panicked investor, who sold basically all his stake very fast and made the stock crash in the process, and guess who bought basically all if that? : Warren Buffett!

Hi KelpieCapital, Yes I have heard, but it still does not look professional or make any sense to me to sell that amount so fast after negative news. That huge selling amount could explain why it fell so much until Buffett stepped in. That said, also lots of things that Buffett has done do not make sense to me, like selling his COP shares after buying so expensive when oil was at 150 and selling so cheap in the worse moments of the crisis, or buying and selling and buying and selling JNJ several times in the last years... so I guess nobody is perfect, seems that we all have some slippery moments.

While British-based Mr Woodford and US-based Mr Buffett have similar 'value' styles, with a focus on old-economy businesses, Mr Woodford has the better track record with British shares. As Buffettologists may know, the American billionaire has made only a handful of non-US stock investments, with British purchases including Tesco and pharma mega-cap GSK.

Thanks for sharing, it indeed is a worrying sign that Mr Woodford sold, he probably is right that competition is getting tougher, I agree with it, and I am not expecting that to change. He has a lot of following in the UK and his sales must have been interpreted like a DANGER sign, to say the least, for lots of institutional investors in the UK, and since Tesco is being mainly traded they could suffer the consequences as a reset in the share price, at least for some time, and the price action las weeks seems to confirm it.

One thing that I would like to know more of is how realistic is the estimation of the 36 billion worth of properties and what the situation of real state is in the UK. I have not found much information beyond hearing that they have lots of properties and their own estimation of worth but nothing more etc... My experience is that owners of real state always say its worth more than what it really is so a more impartial source would be nice. If you have some info on the subject please let me know at [email protected]

Now I'm going to read the articles you mentioned, thanks and best wishes!

I can say having been a UK customer (not recently I moved abroad) that they have a fantastic franchise. In terms of their loyalty system giving advantages on everything from car/house insurance, banking, petrol and grocery shopping (of course), it's a huge advantage to shop there. Add to that the fact that they've historically always hit the nail on the head with price vs choice vs quality and you realise it's an astounding business, hence their 30% uk market share and superior margins. Anecdotally, I have friends I saw before Christmas who save their loyalty points all year in order to do their Christmas shopping there for free.

Yes, there's been a bump in the road with respect to their seasonal marketing, and from watching the ads over Christmas, Sainsburys aced it this year. What I do like is the acceptance of the problem and the immediate reshuffle of management and rejig of strategy, less out of town super stores etc.

They evidently have a focus on return on capital invested, and that's great, as it suggests that high capex will be accompanied by high returns on capital or a change in strategy. This is clearly in evidence through consistent high growth over the last twenty years.

Finally, as you put it, you can buy this business for less than the current price of the real estate; in what is an island that has a population of 62 million people and growing (not counting foreign operations of course).

For me it's as close to a no brainer opportunity as I've seen for quite some time (I have taken a position recently), it may take some time to shake out with the European uncertainty at present, but I'm not loosing sleep on that question.

Thanks Juan, great article As a UK TESCO investor, who also filled up on the latest dip, I thought I would give a perspective on Tesco (TSCO.L) for you guys who are not familiar with the UK retail scene.

I don’t consider myself anything more than investment amateur status at this time but I followed my instincts, my personal knowledge of the stores and Buffett on this one – I was not aware that Tesco owned more of its property than most supermarket groups here in the UK, but if that’s the case – great! In the article you refer a lot to “real state” – I presume you mean real estate.

In my view Tesco is a great business. From humble beginnings as a pile it high sell it cheap grocer started in London in 1919 by Jack Cohen, it grew over the last 20 years or so under the retailing management genius of Terry Leahy to become the biggest supermarket group in the UK branching out into clothing, electrical, books, music & DVDs, insurance, banking, mobile phones, petrol retailing etc with Internet and home delivery sales taking an increasingly important share. See: http://www.tescoplc.com/about-tesco/our-history/ and http://en.wikipedia.org/wiki/Terry_Leahy

Leahy retired last year with the usual unfortunate consequences when someone new has to follow a brilliant act – everyone then has their doubts things will continue to be successful – and events such as a Christmas sales profits slump, a mishandled discounting drive, some senior level defections and staff unease and you see why some investors lost confidence – but not Buffett.

All organisations go through ups and down and no one goes on forever as Buffett is too well aware of, but sooner or later with a big company success will strike again because problems get sorted out. The new incumbent has good pedigree as the BBC article reports “Phil Clarke is Tesco through and through. He's been running the international business well and was seen as one of the leading internal candidates."

About 20 or 30 years ago TESCO went through a bad patch as it was then conceived as being at the discount end “pile it high, sell it cheap” end of the market. It went up market or middle market I would say and never looked back.

Apart from M&S which has met with mixed success, Tesco is the only one to go international. International exposure and particularly in Asia and perhaps Europe, despite problems, in my opinion, bode well for Tesco’s growth prospects in future.

Their US (West Coast) adventure is still really a trial but has met with a mixed response – who thought up the name “Fresh and Easy” which my US friend thought was hilarious, with its unsavoury sexual undertones – who were their US marketing consultants on that one?

Tesco have stated they are changing their approach and not building any more or fewer hypermarkets, which always meet with local howls of protest. They have more recently been filling in the gaps with small local stores and a move to Internet sales for particularly non-food.

I don’t see Amazon being a major threat, as good as they are – I use them all the time, but have you seen their 60 or 70 PE? – because generally Tesco have a loyal following and their club card data base with discount vouchers gives them like Amazon a major behavioural insight and contact medium with their huge customer base.

I’m placing my faith in the continued growth and prosperity of a great company.

Great overview of the UK supermarket scene and TomEnt thanks for pointing out about the typo! I corrected it for real estate now :)... What a shame sorry, English is like my 3rd language, and evidently not mastered yet..

They have unique competitive advantages with all their diverse growing businesses. They can cross-sell to their customers several products like: banking, insurance, petrol, clothes, electronics.

They can use their customer card that Japeel describes to keep track of their customers behavior and act upon that information.

Their international expansion is also quite unique, and it is proven to be a great growth driver, if Asia keeps growing like that and reaching critical scale it could be a very important source of income maybe even bigger than the UK

Their properties should put a floor on how much the stock can fall and even help it recover once they are duly recognized, a lot of investors are not taking that into account I believe. Plus their owned properties give them advantage over Amazon to sell online because they own 100's of them that can instantaneously be used for storage or pick up points at much lower cost than Amazon since they are also used for their normal operations, creating there a great synergy. Their existing properties can even be used as banking branch points making the life of the client easier.

TomEnt, now that I think of it Fresh and Easy would be perfect as the name of a sexual shop due to its undertones. Fortunately I think Americans are not focusing on that, I guess their different humor and double sense do not in general detect such things as well as the British :).

1/ The real estate Tesco is in has value MOSTLY because they are there I would think. They attract footfall and value to the surroundings. So the value embedded would disappear before Tesco goes bust and is sold in pieces. Also, who else would take over?

2/ Amazon and Tesco have approximately the same estimated online turnover in the UK for 09/10: gbp2.25bn.

3/ Their delivery/online shopping sarted in 1995 for the records and has been profitable since 2001.

Exactly due to the fact that "they are there", bought properties cheap and developed a supermarket in place they do not need to liquidate, they extract their value in several ways: sell them gradually, and lease them back, via securitisation, making REITs out of them, or via joint ventures, extracting a nice profit in that cycle and repeating elsewhere the same operation. You may see them as real estate developers.

Actually they do not even need to sell them, they provide a great margin of safety, retailers that own property do much better in hard times and can borrow money at cheaper rates of interest.

Even if they liquidate, merge or are taken over, there should be enough interest in prime developed retail locations.

Hi Cesc, Net debt is 6.7 billions, that makes the whole difference, you can see it from the audited financial reports directly from the company, I never rely on services such as yahoo, msn or google finance, they make huge errors, best source to look for numbers is audited reports or the SEC.

Tesco is 1st or 2nd in most of the countries where it's present... that's real strength, and you buy the whole company for less than it's properties, for me its the best investment Ive seen in a long time. And Buffett seems to agree, he's adding aggressively lately.

I love McDonalds, but I personally think they sell junk food, I don't know for how long people will keep on eating that, but mostly its not cheap at all, and since I love to buy for 50 cents on the dollar, I stay out.

Hi Delusion, Strange that you mention Euros, if you send me the source of information I could maybe comment on that, it could be the net present value of all future leases (rent payments) via joint ventures, distributed troughout all its future lifetime, but I still find that strange and find the figure high at first sight. I checked and only saw a 4 billion off-balance amount related to Tesco Bank in the year report.

Leases amounts are not high, on the contrary, they own around 70% of its properties, so they lease very little compared to their peers, doesn't worry me, it rather reassures me to know they are mainly owners and are less dependent on landlords and changes in the values of lease payments.

Also be aware that companies can move liabilities 'off-balance-sheet'. Tesco has sold a number of its stores to property firms while agreeing to rent them for an agreed term. This is known as 'sale and leaseback'. Tesco gets a cash sum (which is on the balance sheet), but the commitment to pay rent in the future is off-balance-sheet. In substance, these payments are liabilities. So the present value of those payments should really be treated as debt. Credit rating agencies sometimes multiply the annual operating lease expenses figure (£927m as mentioned) by eight to get an estimate of this off-balance-sheet debt – this would give a figure of £7.4bn for Tesco's 2010 accounts. Arguably, its pension fund deficit of £1.84bn represents a long-term liability that also could be seen as a form of debt.

The German article also mentions that if all leasing liablities are considered as debt, EBIT would rise substantially because now all leasing payments go into the Profit/loss statement, while under the new regime they would not go there completely: So definitely worth considering but then again those are rent payments discounted to net present value, that's inevitable if you lease and sell your properties you will get cash today but will in exchange need to rent, there is no other way around that. Either you own or either you pay rent :). It all depends how you interpret it, if you consider the huge net present value of the lease payments then you have to also consider that the properties are basically yours for several years therefore you can also consider them as an asset that would off-set most of the debt. Or on the other hand you can consider simply small annual lease payments and then you don't consider you have a huge liability nor asset. As I see it it makes no difference how you look at it but if you want to look at it as a debt then you should also consider that the assets are yours for several years to be consistent. Recognizing all future lease payments would be a similar situation to viewing the property assets as if they were yours.

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